April 25, 2012 | Issue #115-4  

Solution to BV ‘branding problem’ could be joint best practices, say participants at TAF roundtable

“There may be a branding problem outside of the business valuation profession,” said Steve Sherman, chair of KPMG’s Global Valuations Committee and the International Valuation Standards Board, in his remarks to participants at the first-ever valuation roundtable held by The Appraisal Foundation in Washington, D.C., this week. Most outside of the BV community “don’t realize that the level of professionalism is as high as it is.”

“Outsiders need to know that at least there's consistency in the thought process, so there isn't too much diversity in execution,” agreed Paul Beswick, deputy chief accountant for the SEC (who recently called on the BV profession to unify standards and credentials). For the next four hours, the 15-member panel—led by Jay E. Fishman (FRA) and Tony Aaron (E&Y)— debated how the BV profession could “take out the noise created by the confusion,” as Paul Barnes (Duff & Phelps) put it. “Why not have all BV groups outsource their best practices work to TAF?” Beswick suggested.

“I think a good first step would be for all the organizations to recognize the AICPA’s IPR&D guide and TAF’s advisory on contributory assets as best practices,” Fishman said. “And there could be a group set up to recommend professionwide adoption of other best practices documents as they become available.” In a follow-up interview, Fishman admitted, “If we can’t do that, I worry there is little hope of doing anything else.”

Are BV appraisers tax affecting anymore?

What was recently one of the most controversial topics in business valuations—the tax affecting of subchapter S corps—seems to have given way under the pressure of the economic downturn as well as the rise of other “hot” BV topics, such as the derivation of the size, liquidity, and/or marketability discount as well as the implied-versus-historical equity risk premium. Recently, a subscriber wrote us to ask, “Does anyone tax affect anymore? If so, what model do analysts use?” That led us to wonder, if they don’t tax affect at the end of the analysis, do they take account of taxes in a DCF analysis by “tweaking” the discount rate? What impact, if any, has the recent research by Fannon and Sellers had on how BV appraisers consider the tax-affecting issue now?

Good questions! We’ve put together a brief, four-question online survey on the current state of tax-affecting among BV professionals. It’ll only take a few minutes to complete, and we’ll publish the results next week. To participate, click here.

Oracle court strikes portions of its own expert’s report

Attention financial and economic experts: You may not want to introduce your damages analysis with the words, “Setting aside what the law may require …” That’s how the court-appointed expert in the high-profile, protracted patent infringement litigation pitting Oracle against Google began his reasonable royalty analysis, adding that “there are good economic reasons” why the value of the Java patents in suit, as of the parties’ 2006 hypothetical negotiations, should be equal to the entire Java IP portfolio. First, if the parties had known that the disputed technology was the most relevant to the Android system, then they would have let it drive the negotiations. Second, even if the parties did not know what subset of the IP portfolio would be the most useful, Google would have acquired an option to use any subset. Third, if Google was interested in writing its own system but decided that it needed to be based on Java-like technology, then it would have licensed the entire portfolio as insurance against later litigation.

But this analysis ignored the court’s prior (and repeated) orders requiring the hypothetical license “to be tailored to the amount and type of infringement that actually occurred.” Moreover, “the reasonable royalty must compensate for the infringing features, but not for non-infringing ones.” Applying this legal standard, the expert’s second and third explanations for equating the value of the IP in suit to the entire Java portfolio “are inappropriate for the hypothetical scenario,” because he failed to consider that, at the end of the negotiations, Google would have gotten a license to the IP in suit and “nothing more,” the court said, with emphasis, granting Google’s Daubert motion to strike these references in the expert’s report. Although his first explanation appropriately assumed that Google would only get a license for the patents in suit, the expert framed his opinion as a conditional, thereby making it unclear whether the parties would have let the IP drive their negotiations. The court denied the Daubert motion pertaining to these sections without prejudice—leaving the door open for both parties to reassert the issue.

Read the complete digest of Oracle America, Inc. v. Google Inc., No. C 10-03561 WHA (N.D. Calif. April 10, 2012) in the next Business Valuation Update; the court’s opinion will be posted soon at BVLaw.

Damodaran: ‘Total beta’ has taken on a life of its own

“The idea of total beta is something I mentioned in passing a number of years ago, but it seems to have taken on a life of its own and is being used in ways I never intended,” Professor Aswath Damodaran (NYU Stern School of Business) acknowledged during his day-long presentation at the 26th annual Valuation Roundtable of San Francisco held last Friday in Berkeley, Calif. “It theoretically applies if you have an investor who is completely undiversified, but you never have that kind of buyer in the real world. At the other end of the spectrum, ‘beta’ applies for totally diversified investors. Investors in private companies are somewhere in between.”

Damodaran also freely allowed that there are “dark” and difficult areas in the field of private company valuation that even he has not yet explored. Liquidity? Marketability? Discounts? Premiums? “Fundamentally, these qualitative factors must at some point show up quantitatively in the cash flows because there are no qualitative dollars,” he reminded attendees, “only quantitative dollars.”

When doing a discounted cash flow analysis, Damodaran also advised analysts to “quit worrying” when they end up with a vast amount of value in the residual, especially in startups and non-dividend paying companies. For these types of businesses, he suggests “figuring out the residual first,” then working backward in the cash flow analysis to tie it into what the company looks like currently.

‘Truncation risk’ often overlooked in early-stage valuations

One of the final takeaways from Damodaran’s address to the San Francisco Valuation Roundtable is the problem with how to interpret venture capital (VC) and private capital (PC) pricing mechanisms. These investors typically don’t explicitly separate out “truncation risk,” which is the relative likelihood that the ultimate return on investment will be zero (i.e., somewhere between getting part of your money back and a complete loss). “VCs and PCs tend to lump the possibility of success in with the possibility of failure by using a single (high) discount rate,” he said, “so you never really know what sort of odds they are putting on the failure scenario for a particular investment.”

Tackling all the dark aspects of early-stage valuations. Tomorrow, April 26, join Mike Pellegrino (Pellegrino and Associates) for Valuing Early Stage Companies and a discussion of the most challenging aspects of appraising startup companies and new private ventures, from early, volatile revenue streams and inexperienced managers to an overreliance on intellectual property and untested business models.

G20 wants FASB/IASB convergence by mid-2013

After their meeting last week in Washington, D.C., the G20 Finance Ministers and Central Bank Governors (G20) issued a 14-point communique in which they expressed their support for “the efforts of the IASB and FASB to achieve convergence to a globally accepted set of high quality accounting standards,” and urged them to meet their target on key convergence projects “by mid-2013, at the latest, in order to achieve a single set of high quality international accounting standards.”

Reading between the lines. The G20’s endorsement of the FASB/IASB convergence project could essentially buy the SEC more time in deciding how and when to permit U.S.-based public companies to use International Financial Reporting Standards (IFRS) rather than the traditional GAAP, at least for purposes of their SEC filings, says a recent FEI post. “Or this statement of the G20 Finance Ministers could potentially be relied upon as showing geopolitical support for an extended implementation timetable by the SEC.”

Don’t miss ‘early bird’ pricing for ASA NY conference

Register by April 30, 2012 and receive a discounted price for the 20th Annual Current Topics in Business Valuation, sponsored by the ASA and its New York City Chapter on May 7, 2012, in the Manhattan offices of PricewaterhouseCoopers. Sessions for this one-day seminar include:

  • An in-depth discussion of Estate of Gallagher v. Commissioner, by Daniel Van Vleet (Stout Risius Ross) and Michael Gregory (Michael Gregory Consulting);

  • Identifying the optimum capital structure for a firm, by Professor John Graham (Duke University);

  • Navigating the WACC versus the IRR in business combinations, by Alicia Grosman (PwC); and

  • An analysis of quantitative DLOM models, by Jonathan Tang (Empire Valuation Consultants) and Sean Dineen (Deloitte Financial Advisory Services).

For more information and to register, click here.

New book on LEAPS and the DLOM

Last week Ronald Seaman (DLOM Inc.) published LEAPS and the DLOM, a new book that takes a closer look at LEAPS—or publicly traded put options—as proxies for determining the discount for lack of marketability (DLOM) on valuing privately held stocks.

“There are numerous definitions of DLOM, some described by valuation scholars and some by various courts,” Seaman writes, in an excerpt from his book. “All of the many definitions of the DLOM have four components in common:

a.) the ability to convert the interest into cash;
b.) the time necessary to convert the interest into cash;
c.) the cost or expense to do so; and
d.) the price at conversion.

“LEAPS provide market evidence of the ‘price at conversion’ component of the DLOM,” Seaman says. “That portion of the discount is often the largest portion of the total discount because of the price risk involved in any lengthy holding period.”

PE investment slows in 1Q 2012, but exits remain strong, says new PitchBook report

Private equity deal flow has declined from the fourth quarter of 2011, says a new report by PitchBook. (BVR's partner on the PitchBook/BVR Guideline Public Company Comps Tool). In the first quarter 2012, there were 321 completed deals totaling $55 billion in invested capital. Other trends that emerged during the 1Q 2012, according to PE Breakdown Report: 2Q 2012 Edition, were:

  • Despite declines in PE investment, exit activity remained strong with 112 companies sold or taken public for a total of $21 billion.
  • Deals under $500 million represented 95% of investment activity.
  • The IT industry continues to increase its share of private equity activity. In the first quarter of 2012, the IT industry was responsible for $10.8 billion in invested capital.
  • PE fundraising remained steady from the second half of 2011, with 26 funds closing on a total of $20 billion of committed capital.
  • PE exits will likely be a major conduit for activity for the remainder of 2012, which will be critical in the reduction of the record 6,087 portfolio companies still being held.



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Copyright © 2012 by Business Valuation Resources, LLC
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